Auditors are an essential part of the corporate landscape, as each company has a mandatory requirement to be audited. For listed companies, they will usually engage one of the Big 4 audit firms to perform a statutory annual audit on the company’s books. The auditor will then provide an opinion on whether the company’s books have been drawn up based on an accurate and fair basis.
The role of auditors is to perform tests on the checks and balances of the company, and investors should note that they are tasked to be watchdogs and not bloodhounds. What this means is that auditors have a duty of care to ensure that the audit picks up areas where there are weak internal controls, or to highlight certain aspects of the financials which the auditor cannot gain comfort on. Their role is not to deliberately look out for fraud or instances of collusion.
Investors need to be aware of the following opinions which may be given to companies, and their implications.
An auditor will issue an unqualified opinion if there are no audit findings uncovered, and the financial statements represent a true and fair view of the business. This is the standard audit opinion issued when there are no major issues relating to the audit, and the majority of companies would fall under this category.
For a disclaimer opinion to be issued, auditors must have been denied access to certain financial information, such that they cannot verify transactions or balances. Without sufficient audit evidence, the auditor will then disclaim responsibility for the financials being true and fair — in other words, they do not express any opinion as they are not in a position to be able to provide one. This type of opinion may also be expressed if there is a limitation of scope to the audit, which may severely limit the amount of information the auditor can gather.
A qualified opinion is more serious than a disclaimer, and suggests that the company may not have adhered to professional accounting standards in the preparation of its financial statements. This could mean that the company has aggressive accounting policies which are outside the scope of what the auditors find acceptable. This could spell trouble for the company as it means certain aspects of their accounting are suspect.
An adverse audit opinion is tantamount to an auditor stating that the financial statements of the company have been misrepresented and/or misstated, and do not represent a true and fair view of its financial performance and health. This is the worst opinion a company can receive as it implies either wrongdoing or unreliable accounting practices.
The Foolish takeaway
Audit opinions are important for investors should the auditor provide anything but an unqualified opinion. Auditors may have something to say on aspects of the financial statements, and these could provide critical red flags for investors to pick up on. Therefore, I would strongly recommend that every investor at least looks through the audit opinion section of an annual report.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.